Lessons From Australia’s Retirement System

Australia’s retirement system consistently ranks among the best in the world, making it a great model for the U.S. Compared with other industrial nations, Australia has low public spending on old-age pensions, according to a paper from the Center for Retirement Research (CRR) at Boston College, “Australia’s Retirement System: Strengths, Weaknesses, and Reforms.” It also has high individual savings rates and rapidly growing retirement savings, according to the paper’s author, Julie Agnew, associate professor of economics and finance at the College of William and Mary, Mason School of Business.

Australia’s system consists of three main components that contribute to its success: the means-tested age pension, mandatory retirement saving program and voluntary savings. Introduced in 1908, the Age Pension is a means-tested benefit funded out of general revenues. It provides basic income to those with earnings and assets less than specified threshold levels. Singles can get a benefit equal to about 28% of the average male wage, and couples about 41%, with benefits reduced or eliminated as incomes or assets increase beyond the threshold, the CRR paper explains.

The second part of the retirement system is the mandatory “Superannuation Guarantee” program, created in 1992. The program requires employers to pay a proportion of an employee’s salaries and wages; the current mandatory savings rate is 9% but it is rising to 12% by 2020. More than 90% of employed Australians have savings in a Superannuation account, according to the paper.

The last component of Australia’s system is voluntary savings, which includes additional contributions to a Superannuation Fund, called “salary sacrifice,” as well as savings outside these tax-advantaged funds.

“One might say that Australia has a good balance between mandatory private savings and targeted public support,” Rafal Chomik, senior research fellow at the ARC Centre of Excellence in Population Ageing Research in Sydney, told PLANSPONSOR. “Those who work need to put away money for their retirement, but where these are insufficient for whatever reason, there is a large safety net in the form of the Age Pension.”

Sources say the idea behind Australia’s retirement system is something that the U.S. can learn from. When it comes to saving for retirement, participants’ behavior is largely influenced by the default rate, said Josh Cohen, defined contribution practice leader at Russell Investments.

Australia has recognized participants’ inertia and has responded with its move to a higher mandatory savings rate. “When individuals are defaulted into savings rates, they tend to stay with the default,” Agnew said. “Many behavioral factors can drive inertia including procrastination and status quo bias. Another explanation is that individuals view defaults as implicit advice to be followed.”

Australia’s System Still Needs Work

Despite many successes in its retirement system, Australia still has shortcomings. Over the past five years, the government has conducted thorough reviews of its system to identify areas to improve. Some of these efforts have been on strengthening the Superannuation Guarantee program, with many reforms designed to help individuals make better investment decisions, the CRR paper says.

The Australian government is promoting an expansion of low-cost “simple advice” and rethinking of advice delivery models, according to the paper. It has also imposed a fiduciary mandate requiring financial advisers to act in their clients’ best interest, which will go into effect July 2013.

Another problem lies in the means-tested Age Pension, which may create incentive to reduce one’s means (by spending savings or investment in assets excluded from the means test) in order to collect a higher means-tested benefit, the paper says. However, it is unknown how large an issue this is.

Both the U.S. and Australia struggle to improve the financial literacy of investors. A recent LIMRA survey that asked 2,000 Americans a series of basic financial and retirement questions found that one-third failed the test (see “LIMRA Reports Financial Literacy Failings”). According to CRR’s paper, more than half of Australian survey respondents incorrectly thought a balanced mutual fund was composted of risk-free assets or replied, “don’t know.”

The Future of U.S. Retirement Reform

As for retirement reform in the U.S., Cohen said he does not foresee mandatory savings adoption in the near future, but he does think there will be increased focus on automatic features and more attention to proposals like Senator Tom Harkin’s (D-Iowa). Last year, Harkin released a report titled "The Retirement Crisis and a Plan to Solve It.” The heart of his plan is a new system of privately run hybrid pension plans, which incorporate many of the benefits of traditional pensions while substantially reducing the burden on employers (see “Harkin Retirement System Proposal Gets Mixed Reviews”). Harkin’s proposal requires that individuals who are not covered by an employer-sponsored retirement plan be automatically enrolled in regulated, privately run retirement funds.

Going forward, the U.S. needs a comprehensive solution to retirement savings that includes some form of mandatory retirement savings, BlackRock Chairman and CEO Laurence D. Fink said during a recent talk at the New York University Stern School of Business. “Given the massive amounts of savings needed – as well as investor psychology and the reality of risk aversion – we need a comprehensive solution to retirement savings that includes some form of mandatory retirement savings, similar to Australia’s successful superannuation system or the new pension requirements in the UK,” he said.

Superannuation in Australia has been a huge success in supplementing the government pension scheme and taking the strain off it, which Fink said is an attractive prospect as the U.S. thinks about how to relieve the burden on Social Security. A mandatory retirement savings system would need to be phased in gradually in order not to create a shock to the economy, he said.

The U.S. also has some good models, Fink said, such as the pooled fund for small employers managed by the California Public Employees Retirement System (CalPERS). “Perhaps we could do something similar nationally by opening the highly successful Thrift Savings Program for federal employees to all workers,” he suggested. “That’s the model being adopted nationally in the UK with the creation of the NEST (National Employment Savings Trust) plan." NEST is an automatic enrollment pension scheme for UK employers of any size (see "100 Plan Sponsors Register With NEST").

Fink said the U.S. could also model a solution on successful pools already created for small employers and non-profits.

“But the point is the current system is broken,” Fink concluded, “and we need a comprehensive approach that includes some form of mandatory savings in addition to Social Security … The current system simply isn’t working, and the longer we wait to fix it, the tougher the task becomes. We need to start the debate today."